Real Estate Tax Reform, Economic Growth and Financial Stability

1 Introduction

China’s real estate market has experienced rapid growth for more than two decades, with the prices rising markedly. A variety of regulatory measures, such as the restrictions on loans, purchases, sales and prices, were made by the central and local governments in recent years to prevent the real estate market from overheating, which have prevented the prices skyrocketing. However, housing prices remain high in general. In this context, the real estate tax reform has once again become the focus of the entire society. China promulgated the Provisional Regulations on Real Estate Tax as early as 1986, with taxes levied mainly on business building, and residential housing has been excluded of taxation for a long time. With the everlasting prosperity of the real estate market, the call is growing for establishing a real estate tax system, including residential housing. The “progressive promotion of real estate tax reform” first appeared in the Circular of the State Council Approving and Forwarding the Opinions of the Development and Reform Commission on the Key Work of Deepening Economic System Reform in 2010 announced on www.gov.cn. Shanghai and Chongqing took the lead in the real estate tax pilot in 2011. The Third Plenary Session of the 18th CPC Central Committee suggested expanding the real estate tax pilot and speeding up the allied legislation. Since the 19th NCCPC, the central government has repeatedly stressed the orientation and guideline of “houses are for housing, not for speculation” in the real estate market, and further clarified the real estate tax reform as a market-oriented policy regulation. The State Council was authorized by the NPC Standing Committee to launch the real estate tax reform pilot in some places in October 2021, marking the expansion of real estate tax pilot and accelerated pace of implementation.

As the primary carrier of social wealth and important financing collateral, real estate connects the real economy and the financial market. The real estate tax may influence housing prices and the allocation of capital resources in the real economy and the financial market to change the macroeconomic landscape. Some scholars pointed out that China’s real estate tax reform might be constrained by multiple objectives (Feng and Liu, 2011) as it needs to ensure the real estate market grows in a sustained, healthy manner in the long run while ensure the steadily growth of the macro economy. Potential systemic risks are still unavoidable issues along with China’s economic growth in the short term. Under the realistic need of preventing and resolving systemic risks, whether the real estate tax reform will increase the shock of possible systemic risks on China’s macro-economy to make it harder to cope with in a short run is also an issue that needs full assessment when implementing the real estate tax. That is, as well as “stable growth”, the real estate tax reform requires “risk prevention”. Therefore, it is imperative to objectively assess and control the long- and short-term impact of the real estate tax on the macro economy and financial stability in China, which is the purpose of this paper.

In retrospect of previous pilot practices in Shanghai and Chongqing, Shanghai levies only on new housing purchased by residents after the pilot and not on housing stock and Chongqing levies more on the high-end housing. Both have exemptions to a considerable extent. From the current discussion on the real estate tax scheme design, the future real estate tax will be a policy package covering all kinds of real estate, including residential and non-residential housing, and historical housing stock. Given that housing has different functions for different economic entities (households, industrial and commercial enterprises) and the same entity has different demands for housing ((e.g. residents’ demand for housing are both rigid and speculative), the real estate tax needs to consider targeted, differential policies. When assessing the long- and short-term impact of the real estate tax on the macro economy and financial stability, it also needs to well compare the differences in the implementation effects of different real estate tax policies as a way to provide alternative reference for policy practice.

From the literature on real estate taxes in developed economies, some believe that the real estate taxes have direct adverse impact on housing prices, but can also improve the government’s public service capacity, indirectly producing positive impact on housing prices (Haughwout, 1999). This varies among countries (Elinder and Persson, 2017). Some also found that the real estate tax reduction and exemption policies drive the housing consumption (Banzhaf et al., 2021), affect the mortgage financing activities and the probability of default (Miller et al., 2019), and has obvious suppression effect on the labor market on the supply side during the real estate boom (Liu and Yang, 2020).

Considering the differences in land systems among countries, the above conclusion may not be fully applicable to China. Some empirical studies hold that the real estate tax role for housing prices is dominated by the suppression effect (Kuang, 2009, 2013; Kuang et al., 2012), showing significant suppression effect on housing prices in pilot cities (Liu and Fan, 2013; Bai et al., 2014). However, some studies found that the real estate tax has no large policy expectation effect on the pilot areas and the impact on housing prices is insignificant (Wang and Cao, 2014). As to the impact on the macro economy, most scholars believe that the real estate tax has significant income distribution effect (Li and Xiang, 2013; Zhan and Li, 2015; Fan and Liu, 2015), which directly influences housing consumption (Zhong and Chu, 2008; Cui et al., 2011), and will influence the industrial transfer of the real economy (Liu and Zeng, 2018).

Most of the above domestic literature analyzes the regulatory effect of real estate tax policies on housing prices from the point of local equilibrium through empirical measurement, so there might be deviations due to the local analysis. For this reason, some scholars started working on the policy effect under the general equilibrium framework. Based on a long-term dynamic equilibrium analysis, Wang and Huang (2013) argue that real estate tax policies can reduce housing prices in the short term, but may push up prices in the long run due to tax transfer. In fact, the impact of the real estate tax on the macro economy is far from a corner of housing prices. Luo and Wu (2012) believe that the real estate tax can stabilize macroeconomic fluctuations caused by housing price changes in the long term. Zhao and Luo (2013) found that the suppression effect of the real estate tax on housing prices is weakened by financial frictions and adversely affects real estate investment. Zhu and Yan (2014) believe that it is more effective to levy taxes on housing stock than on new purchases. Meng et al. (2017) discuss the transmission mechanism and coordination effect of credit policies and real estate tax policies under different external shocks. It is found that credit policies work better on regulating housing prices under the shock of monetary policies, while the real estate tax performs better under the shock of housing preference. While the literature has laid an important foundation for expanding and deepening the research, few of them discussed the timing of levying the real estate tax in China. Zhang (2020)’s recent study suggests that it may be right to levy the real estate tax at the time when the housing bubble is squeezed and housing prices stay relatively stable.

Despite the literature with important enlightening ideas for subsequent research, there are the limitations as follows: First, few studies analyze the real estate tax’s impact on the long-term economic steady-state path in the general equilibrium framework, which is crucial for assessing the long-term impact of policies. Second, most of the above studies ignore the natural fact that potential systemic financial risks are facing China’s economy in the current and future periods, and whether the real estate tax may make it harder to protect against risks is not well assessed. Third, the existing literature lacks discussions on different real estate tax reform schemes and the comparison of policy effects needs deepening. These are the issues that need to be objectively understood in advance when long-term goals and short-term tasks such as stable growth and risk prevention are taken into account for the current real estate tax reform in China.

In view of the above literature and the awareness of problems in real estate tax reform, this paper introduces the levy of the real estate tax, based on the Iacoviello(2015)’s multi-sector DSGE model of housing stock. It aims to investigate the long-term impact of real estate tax policies on economic growth and financial stability, which are based on the unified tax base assessment ratio and differential tax base assessment ratio that suppresses excessive household housing holdings and encourages enterprise investment in productive housing. This paper analyzes the short-term impact of the above two types of real estate tax reform schemes on economic fluctuations and financial risks under the background of potential financial risks facing China’s economy. Based on this comparison, sound real estate tax policies are put forward for the unity of “stable growth”, “risk prevention” and “reform”. The results show that: for economic growth and financial development in the long run, the real estate tax presents significant “suppression effect” of housing prices and “redistribution effect” on the housing market. The housing transfer from the household sector to the enterprise sector grows the economy, boosts household consumption, and is good for reducing the household housing price-to-income ratio, suppressing the excessive increase in household leverage and asset bubble risk. For economic fluctuations and financial risks in the short-term, when faced with systemic financial risks, the real estate tax will not intensify the impact and will not hinder the prevention and mitigation of systemic financial risks. Different real estate tax policies have different impact on economic growth and financial stability. Compared with the real estate tax with unified tax base assessment ratio, the real estate tax with differential tax base assessment ratio will help the coordinated development of financial activities and the real economy in the long term and play a stronger role in economic growth, which contributes to the unity of “stable growth”, “risk prevention” and “reform”.

This paper has the following contributions: first, based on long-term economic operation, the impact of real estate tax policies on the steady-state path of economic system is investigated and the effect mechanism is revealed. Second, from the perspective of facing systemic financial risks in the short term, the impact of real estate tax policies on economic fluctuations and financial risks is simulated and analyzed, which responds to the realistic concern about whether levying the real estate tax mounts the pressure of risk prevention, and with a long-term analysis, the impact of the real estate tax reform on the macro economy and financial stability is assessed more comprehensively. Third, advantages and disadvantages of the two types of real estate tax reform schemes are compared and analyzed as reference for implementing real estate tax policies towards the goal of “stable growth”, “risk prevention” and “reform”.

The remaining contents are as follows: theoretical model (sec. 2), parameter setting (sec. 3), simulation analysis on the long-term impact of the real estate tax with unified tax base assessment ratio and differential tax base assessment ratio respectively (sec. 4 and 5), analysis of the short-term impact of the real estate tax on economic fluctuations and financial risks (sec. 6), and conclusions & policy implications (sec. 7).

2 Theoretical Model

3 Parameter Setting

In terms of ν, the share of housing in the production function: it is approximately replaced with the share of investment real estate held by manufacturing enterprises in listed companies to all fixed assets. Wind shows that this average share in China over the past 15 years is 4.88%, so the value of ν is set at 0.05.

In terms of γ_E, the bank leverage ratio: the capital adequacy ratio shall not be less than 8%, and a reserve capital of 2.5% shall be set aside, according to the Measures for the Administration of Commercial Bank Capital (Trial) (2013 Ver.). At the same time, the counter-cyclical capital buffer ratio of commercial banks is initially set at 0 in China, according to the Establishment of Counter-Cyclical Capital Buffer Mechanism released and put into effect in September 2020. The minimum capital adequacy ratio on aggregate is 10.5%, hence the leverage ratio is set at 89.5%.

In terms of m_H, the housing mortgage LTV: the down payment ratio of mortgage loan for the first housing is generally 30% and the minimum capital ratio for fixed-asset investment of enterprises is mostly 30%, so it is set at 0.7. For the wage prepayment ratio m_N, the law stipulates that wages shall have the priority of repayment in the enterprise debts and shall be paid in full, so it is set at 1.

In terms of the subjective discount factor: it needs not only the relational equation between the parameters in the steady state of the model but China’s real economic data to calibrate it. ^[1] Since the average one-year-term deposit interest rate in China was 1.9007% in the past 15 years, converted to a quarterly value of 0.475%, so it is set at 0.9953. Over the past decade the average mortgage loan interest rate of financial institutions was 4.6671 %, so β_B is set at 0.9340 and β_E at 0.9221 based on the relationship among the parameters.

On the elasticity of labor supply, Hou and Gong (2014) estimate it to be 0.4857 by the Bayesian method with the data of China, but Domeij and Floden (2006) considere that this method has an underestimation of 50% deviation, so the elasticity of labor supply is set at 1, and τ at 2 accordingly. For enterprise and bank loan adjustment cost factors ϕ_EE and ϕ_EB, both set at 0.25, citing the setting of Iacoviello(2015). For the inertial coefficient ρ of financial shocks and the standard deviation σ, since China has not yet experienced a substantial financial crisis, no estimate of the coefficient is found in existing literature. Then citing Iacoviello (2015), ρ is 0.9, σ is 3.8 ‰ of the total output steady-state correspondingly. The calibration of main parameters is shown in Table 1.

4 Long-Term Impact of Real Estate Tax with Unified Tax Base Assessment Ratio

Most major economies in the world are 10%-20% in terms of the tax base assessment ratio, so the analysis in this paper is based on a tax base assessment ratio of 10%. In terms of tax rates, given that the pilot tax rates in Shanghai and Chongqing range from 0.4% to 1.2% and the global real estate tax rates are mostly kept between 0.5% and 3%, we take the cases where the real estate tax rates are 0.4%, 0.6%, 0.8%, 1.0% and 1.2% respectively for analyzing the long-term impact.

4.3 Selection of the Tax Rate of Real Estate Tax with Unified Tax Base Assessment Ratio

The tax rates of the real estate tax vary among major economies, with some of them close to 3%. A natural question is how to select the real estate tax rate with unified tax base assessment ratio in China. Tables 2 and 3 show mainly the discrete tax rate analysis and may omit the turning point in the continuous changes of tax rates. So theoretically, a more comprehensive analysis of the impact of tax rate selection on the steady-state path of the economic system in a long term is in need.

As shown in Figure 1, as the tax rate rises, housing continues to move from households to enterprises, housing prices fall significantly but slowly, with a significant decline in the housing price-to-income ratio and a continuous rise in resident consumption and the total output. However, there is a marked turning point in the long-term impact of the rise in tax rates on the financial system. Deposits and credits increase as the real estate tax rate is low and decrease when the tax rate is high. The mechanism for this result is that: when the tax rate is low, the sum of the “income effect” and the “crowding-out effect” is greater than the “direct effect” of the tax increase on the supply side of credit funds, while the “redistribution effect” is greater than the “suppression effect” on the demand side; the credit market shrinks instead when the tax rate is high. The numerical simulation shows that the tax rate at the turning point is approximately 2.98%. Therefore, when applying real estate tax policies with unified tax base assessment ratio, on selecting the tax rate, the coordination between financial activities and economic growth must be taken into account to exert the financial support to the real economy.

Figure 1

Steady-State Change Path of Main Variables in the Case of the Real Estate Tax with Unified Tax Base Assessment Ratio

5 Long-Term Impact of Real Estate Tax with Differential Tax Base Assessment Ratio

The foregoing results indicate that real estate tax has “redistribution effect” on housing and that the impact of real estate tax on different economic entities is largely different. It provides enlightenment for applying real estate tax policies with differential tax base assessment ratio. The long-term macroeconomic impact of real estate tax with differential tax base assessment ratio on different economic entities is analyzed in depth in this section.

5.2 Design Logic of Real Estate Tax with Differential Tax Base Assessment Ratio

Comparing the results of Figures 2 and 3, it is found that: for the taxation on households and on enterprises, respectively, the trend is just the opposite regarding the indicators such as housing distribution, total output, household consumption and savings and bank credits, but it is the same as to housing prices and price-to-income ratio. It reveals that both the taxation on households and enterprises have great “suppression effect” on housing prices and price-to-income ratio, which is stronger when the tax is levied on households. There are also differences in the mechanism of reducing the housing price-to-income ratio: when taxing households, the “redistribution effect” causes the enterprise housing holdings to rise, and then the total output and household income grow, and with the “suppression effect” on housing prices, the housing price-to-income ratio decreases. However, the “redistribution effect” is the opposite when taxing enterprises. That is, total output and household income decline, while the “suppression effect” of real estate tax on housing prices was relatively greater, resulting in a decrease in the housing price-to-income ratio. From the long-term, stable performance of the financial system, levying on households is better for the coordinated development of financial activities and the real economy than on enterprises.

Figure 2

Impact of Household Real Estate Tax Rate on Steady-State Path of Main Variables of the Model

Figure 3

Impact of Enterprise Real Estate Tax Rate on Steady-State Path of Main Variables of the Model

From the marginal effect of tax rate, the reduction of housing holdings brought by the same tax rate imposed on enterprises is significantly higher than that imposed on households, and the taxation on households will bring about a greater increase in output. This means that the emphasis should be placed on tax control of excessive housing holdings of households, while tax incentives should be applied to the productive housing of enterprises, i.e. the real estate tax policies with differential tax base assessment ratio, which suppress households’ excessive housing holdings and encourages enterprise investment in productive housing. The economic logic behind it is that the housing held by residents is separated from the production, and then excessive holdings will cause obviously adverse externalities to social production. In recent years, an important manifestation of the “off-real to virtual” economic development of wide concern is that residents’ enthusiasm for purchasing housing is excessively high. A large amount of economic resources have entered the real estate field and caused a large amount of productive resources to precipitate, which is bad for the high-quality economic development. The real estate tax on the household sector will raise the cost of holding housing, taking precipitated housing (such as housing purchased for consumption, investment or even speculation purposes) into production, thereby alleviating the “off-real to virtual” economic development.

Based on the analysis, from a long-term perspective, the real estate tax with differential tax base assessment ratio, which curbs households’ excessive housing holdings and encourages enterprise investment in productive housing, is more advantageous than that with unified tax base assessment ratio. As well as achieving similar policy effects of the latter, policies with differential tax base assessment ratio are better for the coordinated development of financial activities and the real economy.

6 Short-Term Impact of Real Estate Tax on Economic Fluctuations and Financial Risks

Apart from the long-term impact of real estate tax policies, another realistic concern against the current background of potential systemic risks is, will the levy of real estate tax intensify the risks, mount the adverse impact of systemic financial risks and make it harder to prevent and resolve the systemic risks? Which policies have the least adverse impact in the short term, those with unified tax base assessment ratio or with differential tax base assessment ratio? The impact of financial risks on macroeconomic and financial variables in the above two types of real estate tax reform schemes is compared and analyzed as follows.

6.1 Short-Term Impact of Real Estate Tax Policies with Unified Tax Base Assessment Ratio

In this paper, three representative tax rates of 0.5%, 2% and 1.2% are selected for simulation analysis under the condition of unified tax base assessment ratio. ^[1] Figure 4 shows the relevant results. The volatility of major economic variables in the case of real estate tax with unified tax base assessment ratio is less than that in the case of no real estate tax, especially the volatility of housing price and credit, two financial variables measuring the financial stability. It indicates that the real estate tax with unified tax base assessment ratio does not intensify the impact of systemic financial risks and will not make it harder to prevent and resolve the systemic risks. Figure 4 also shows that within a certain tax rate range, economic fluctuations fall with the rise of tax rates. However, it is not a strictly monotonous relationship. When the tax rate exceeds a certain limit, economic fluctuations rise with the increase of tax rates (as shown by the tax rate of 2%).

Figure 4

Short-Term Impact of Real Estate Tax with Unified Tax Base Assessment Ratio in the Case of Systemic Financial Risks

6.2 Short-Term Impact of Real Estate Tax Policies with Differential Tax Base Assessment Ratio

Similarly, three representative real estate tax rates of 0.48%, 1.82% and 1.2% are selected for simulation analysis of the short-term impact of differential tax base assessment ratio, when the real estate tax is levied on households and completely waived for enterprises. ^[1] Figure 5 shows the impact on the economic system of real estate tax policies of different tax rates and with differential tax base assessment ratio (only for households, tax-free for enterprises) when facing systemic financial risks. The volatility of major economic variables in the case of real estate tax is less than that in the case of no real estate tax, especially the volatility of housing prices and credit, two financial variables measuring the financial stability. It suggests that the real estate tax with differential tax base assessment ratio does not intensify the impact of systemic financial risks. Economic fluctuations fall with the rise of tax rates within a certain tax rate range, but increases with the rise of tax rates beyond a certain limit (as indicated by the tax rate of 1.82%).

Figure 5

Short-Term Impact of Real Estate Tax with Differential Tax Base Assessment Ratio in the Case of Systemic Financial Risks

A further question is whether the short-term impact of the two types of real estate tax policies on economic fluctuations and financial risks is different. Figure 6 compares the short-term performance of the two types of policies at the same tax rate when facing systemic financial risks. The results show that the economic fluctuations are almost the same, revealing that the real estate tax will not affect the transmission mechanism of systemic financial risks, and that in the short term, the way of levying the real estate tax will not adversely affect the prevention of systemic financial risks.

Figure 6

Comparison of Short-Term Impact of the Two Types of Real Estate Tax Policies in the Face of Systemic Financial Risks

7 Conclusions and Policy Implications

By constructing a multi-sector DSGE model embedded with tax wedge, housing mortgage financing constraints and bank supervision constraints, this paper investigates the long-term impact of the real estate tax policies on economic growth and financial stability, which are based on the unified tax base assessment ratio and differential tax base assessment ratio for two major housing owners (household and enterprises). It also compares and analyzes the short-term impact of the above two types of real estate tax reform schemes on economic fluctuations and financial risks under the background of potential financial risks facing China’s economy. The results show that:

In the long run, the real estate tax shows significant “suppression effect” on housing prices and “redistribution effect” on the housing market, boosting economic growth and household consumption. At the same time, it effectively reduces the household price-to-income ratio and suppresses the excessive increase in household leverage and asset bubble risk. Different real estate tax policies have different impact on the financial system. The real estate tax with unified tax base assessment ratio is good for boosting the supply and demand of credit funds when the tax rate is low and will cause the credit scale to shrink when the tax rate is high. The real estate tax with differential tax base assessment ratio, which restrains households from excessive housing holdings and encourages enterprises investment in productive housing, will avoid it and is better for the coordinated development of financial activities and the real economy. In the short run, from the perspective of economic fluctuations and financial risks, the real estate tax will not intensify the impact of systemic financial risks, so it will not adversely influence the financial stability.

With the analysis of the short-term and long-term impact, this paper holds that the real estate tax with differential tax base assessment ratio is more advantageous than that with unified tax base assessment ratio, as it will achieve similar effects as the latter as to growing the economy and maintaining financial stability and is better for the coordinated development of financial activities and the real economy.

With the above conclusions, this paper suggests that the future real estate tax reform should focus on as follows.

First, the progress should be gradual and prudent. On comprehensively drawing on the real estate tax reform pilot projects in Shanghai and Chongqing, the long- and short-term impact of the real estate tax on economic growth and financial stability needs to be assessed from the point of achieving high-quality development and preventing and resolving systemic financial risks, rather than only for controlling housing prices.

Second, properties of housing, such as residence, investment, speculation or production, should be systematically divided when designing real estate tax schemes, based on the differences in housing demand and holding purposes of economic entities. The real estate tax policies with differential tax base assessment ratio, which have exemptions, should be launched in a targeted manner. A moderate tax base assessment ratio should be applied for residential housing to meet reasonable demand, and a higher tax base assessment ratio for speculative housing to increase the tax burden on the holding, and a lower ( or even zero ) preferential tax base assessment ratio for productive housing to help allocate more resources to the production sector.

Third, a stable macroeconomic and financial environment is the essential prerequisite for the real estate tax reform results. Currently, there are many exogenous uncertainties in the domestic and foreign economies under the COVID-19 impact. We still need to keep enough vigilance against risks, reserve sufficient policy space and take the timing of launching the real estate tax reform schemes for the macroeconomic stability.